Hilltop Holdings Inc. — Q2 2016 Form 10-Q
Reporting period: Three and six months ended June 30, 2016; balance-sheet comparisons are to December 31, 2015. Hilltop is a financial holding company with banking, broker-dealer, mortgage origination and property-and-casualty insurance businesses. Dollar amounts below are in millions unless stated otherwise.
Financial performance
| Metric | Q2 2016 | Q2 2015 | Six months 2016 | Six months 2015 |
|---|---|---|---|---|
| Net interest income | $100.4 | $100.7 | $194.2 | $194.1 |
| Provision for loan losses | $28.9 | $0.2 | $32.3 | $2.8 |
| Noninterest income | $346.0 | $301.4 | $623.4 | $654.2 |
| Noninterest expense | $367.4 | $353.3 | $692.6 | $667.8 |
| Income before taxes | $50.2 | $48.6 | $92.8 | $177.7 |
| Net income attributable to Hilltop common stockholders | $31.1 | $29.6 | $58.6 | $141.5 |
| Diluted earnings per share | $0.32 | $0.30 | $0.60 | $1.41 |
- Taxable-equivalent net interest margin was 3.80% in Q2 and 3.76% for the first half, versus 3.75% and 3.66%, respectively, in 2015. Purchase-accounting accretion materially supported reported margins.
- At June 30, total assets were $13.08 billion, deposits $7.13 billion, non-covered loans net of allowance $5.42 billion, covered loans net $322.1 million, and stockholders’ equity $1.80 billion.
- Cash and cash equivalents were $613.7 million, down from $669.4 million at year-end. Six-month operating cash flow was negative $375.1 million; investing cash flow was negative $101.7 million and financing cash flow positive $421.0 million.
- Short-term borrowings were $1.01 billion; notes payable were $319.6 million and junior subordinated debentures $67.0 million. Hilltop had $79.7 million of freely available holding-company cash. The $150 million senior notes carry a 5% coupon and mature in 2025.
- Hilltop’s total capital-to-risk-weighted-assets ratio was 17.69%; the Bank’s was 15.51%. The Bank was classified as well-capitalized.
Material changes versus comparable periods
- Q2 common earnings increased to $31.1 million from $29.6 million, while first-half common earnings fell to $58.6 million from $141.5 million. The prior-year period included an $81.3 million SWS merger bargain-purchase gain, while 2016 included a large loan charge-off and substantially higher loan-loss provisions.
- In Q2, mortgage origination and broker-dealer results improved. Mortgage pretax income was $28.1 million versus $21.1 million; broker-dealer pretax income was $18.3 million versus a $1.9 million loss. Banking pretax income declined to $21.6 million from $45.3 million, principally because of the loan loss provision. Insurance remained loss-making, with a $9.6 million pretax loss versus $12.5 million.
- Mortgage origination volume increased 8.3% in Q2 and 6.5% in the first half. Home-purchase volume rose while refinancing volume declined. Broker-dealer income benefited from stronger derivative and trading activity, partly offset by lower commissions and advisory fees.
- Deposits increased $174.1 million from year-end; total assets rose $1.21 billion. Broker-dealer receivables and payables increased substantially, reflecting higher securities financing activity.
- The combined Hilltop Securities firm began operating after FSC merged into Hilltop Securities on January 22, 2016. Management reported early cost savings, partly offset by integration expenses.
Outlook, commentary and risks
- The filing provides no numerical earnings or revenue guidance. Management notes that mortgage origination is seasonal and more volatile than other segments; future activity is sensitive to interest rates, refinancing demand and home purchases.
- Management described the $24.5 million charge-off as arising from an isolated, defaulted non-covered loan involving irregularities, including concerns about underlying documents and the borrower’s operations. The Bank is pursuing legal remedies but cannot estimate potential recoveries or further costs.
- Insurance results remain exposed to severe weather and seasonal claims. Rate actions and efforts to reduce geographic and product concentrations have constrained premium growth; reinsurance limited the company’s retained losses on certain sub-catastrophic events. Q2 and first-half combined ratios were 130.0% and 108.9%, respectively.
- The Bank’s FDIC loss-share arrangements may require a future “true-up” payment; the recorded accrual was $9.4 million. Covered-asset estimates and reimbursements may change.
- Other disclosed risks include real-estate loan concentration, credit-loss estimation, interest-rate movements, SWS integration, broker-dealer financing and counterparty exposure, cyber risk, reinsurer performance, and regulatory change. The filing says the detailed market-risk disclosures were not materially changed from the 2015 Form 10-K; the Bank was asset-sensitive in its gap analysis, with modeled net interest income increasing under rate-rise scenarios.
- Pending matters include SWS shareholder appraisal petitions, litigation relating to the 38 Studios bond financing, and a DOJ investigation concerning PrimeLending FHA loan origination and underwriting. The company says it cannot estimate potential liability for the PrimeLending investigation; management believes pending matters will not have a material overall effect, while acknowledging adverse outcomes could be material in a particular period.
- A $50 million share repurchase authorization was approved in Q2; no shares had been repurchased under the program by June 30. Separate April share repurchases were for employee tax withholding.
- Management reported effective disclosure controls and no material quarterly change in internal control over financial reporting. The filing also revised the presentation of 2015 cash flows for a classification error, stating there was no effect on financial condition or operating results.
Most important facts for investors to verify
- Details, collateral, recovery prospects and any subsequent developments related to the $24.5 million loan charge-off and the investigation of the borrower.
- Whether credit costs remain elevated after the unusually large Q2 provision, and how allowance levels and nonperforming assets develop.
- Sustainability of mortgage and broker-dealer earnings, including the contribution of fair-value, derivative and trading gains versus recurring activity.
- Mortgage servicing-rights valuation and sensitivity: the MSR asset was $33.5 million at June 30, down from $52.3 million at year-end, with significant sensitivity to prepayment assumptions.
- Insurance loss development, weather exposure, reinsurance recoverability, premium trends and the $9.4 million FDIC true-up accrual.
- Funding and liquidity needs, particularly mortgage warehouse-line utilization, broker-dealer financing balances and the composition and concentration of deposits.
- Progress and realized savings from the SWS integration, and status or potential financial impact of the disclosed litigation and regulatory inquiries.